Rethinking Commodities

Abstract

Commodities have long been viewed as the poor cousin in the investment universe, and often for a good reason. Unlike equities, commodities do not offer a so-called market beta with prices drifting higher over time in line with economic activity. In contrast, they present a collection of unique price returns that reflect the underlying supply and demand dynamics of physical assets that serve as the global economy’s building blocks. This article takes a new look at commodities as an asset class and at their uses in a portfolio, which historically have been diversification and inflation protection. The authors analyze different commodity beta allocations and identify alternative investment uses of commodities. Such uses include building blocks to express particular investment themes, tactical trading tools, and multiasset risk premia allocation components.

TOPICS: Commodities, portfolio construction, financial crises and financial market history

Key Findings

• ▪ Although investors have rightly questioned the benefits of commodities in a diversified portfolio over the past decade, there may still be some validity to the diversification and inflation protection arguments touted by long-only commodity advocates.

• ▪ Evidence suggests a positive relationship between the level of inflation and returns of a broad basket of commodities. The contemporaneous nature of this relationship can make it difficult to capture unless exposure is held continuously, which may be an unjustifiable drag on the performance of a diversified multiasset portfolio.

• ▪ The commodities market is well suited to risk premia strategies. It is a unique market in which participants with different objectives interact on a futures curve, thereby creating persistent and harvestable risk premia.